I am a convicted felon, former CPA, and former criminal CFO of Crazy Eddie. Today, I teach law enforcement agencies, professionals, and businesses how to identify fraud and train them to catch the crooks. Red flags investigated in this blog are often reported to appropriate government agencies as a whistleblower. --- Sam Antar

Tuesday, July 08, 2014

A Felon’s View of White-Collar Crime - Why Society is Very Vulnerable to Fraud

White-collar crime is more brutal than violent crime. The actions of one or a few corrupt public officials and corrupt businessmen can affect the livelihoods of thousands, even millions of people. Fraudsters use a combination of persuasion and deceit to execute their crimes. Unfortunately, most people are unaware of how easy it is for fraudsters prey on their behavioral and cognitive vulnerabilities. Furthermore, the amount of prosecutions of white-collar criminals recommended by the FBI has steadily declined over the last 20 years. The government devotes far more resources to battling street crime than white-collar crime. The current framework involving, compliance, audits, and law enforcement does little to protect investors from fraud.

Every person is capable of doing white-collar crime. At the 22nd Annual Conference of the Association of Certified Fraud Examiners Conference in San Diego California in 2011, Joan Pastor, PhD, Clinical Psychologist and Fraud Expert said, “We’re all capable of committing fraud. Every single person in this room is capable of committing crimes.” For all of us, ethics is a matter of convenience depending on the situation and pressures involved. White-collar crime is an inevitable byproduct of the human condition. Seriously, can anyone truthfully claim that they live without sin and temptation?

At best, people can prevent themselves from being victims of fraud. However, there is relatively little that our society can do to stop fraudsters from victimizing other naive and vulnerable people. If you are smart enough to avoid being victimized by a fraudster, they will simply find someone else with an exploitable weakness. Everybody has an exploitable weakness. The fraudster's job is to find the people who have an exploitable weakness that he/she can take advantage of.

Exploitable Weaknesses

White-Collar criminals use a combination of persuasion and deceit to achieve their objectives. Fraudsters prey on the psychological and cognitive vulnerabilities of their victims using the following techniques:

White-collar criminals consider your humanity, needs, desires, ethics, morality, and good nature as weaknesses to be exploited in the execution of their crimes.

White-collar criminals measure their effectiveness by the comfort level of their victims. They use a combination of charm and deceit to achieve their objectives. It’s far easier to get a potential victim to believe your lies, if they like you.

White-collar criminals fabricate false integrity to gain the trust of their victims. Stature, generosity, and good deeds gain the respect of their potential victims and make it less likely that victims will question their behavior.

White-collar criminals will always have the initiative to commit their crimes. Your ethics, morality, and good nature limit your behavior, but fraudsters have no such constraints on their behavior. The ethical foundation of our society is based on trust and legal basis of our society is based on the presumption of innocence. The inclination to trust and the presumption of innocence gives the fraudster the initial benefit of any doubt while they are free to plan and execute their crimes. Therefore, trusting and decent law abiding human beings are easier prey for fraudsters.

It's common knowledge that effective internal controls, oversight, and checks-and-balances reduce the opportunity for fraud. However, people tend to ignore the fact that their trust, ethics, and good nature limit their behavior and create a fertile opportunity for white-collar criminals to seize the initiative and execute their crimes. Fraudsters are unfettered by society’s moral constraints on behavior.

Crime and Punishment

Many people mistakenly believe that strong punishment such as long prison sentences is a major deterrent to white-collar crime. Recently, many white collar criminals have received very stiff prison sentences, which I firmly support. At best, it holds those guilty of white-collar crime accountable and responsible for their actions. However, strong punishment does relatively little to prevent white-collar crime. Often, we watch prosecutors pound the podium in front of the cameras and claim that their latest successful case sends a strong message to fraudsters to stop doing crime. However, white-collar criminals don't listen to the rhetoric of prosecutors. No white-collar criminal discovers ethical behavior and stops doing crime because another criminal ends up in prison. While white-collar criminals take precautions against failure, they do not plan on ever ending up in prison.

Don't Trust. Just Verify

Trust is a hazard that will destroy your future livelihood. While you initially give a fraudster the benefit of the doubt, they will attempt to solidify their trustworthiness before you follow up to verify their claims. The fraudster hopes that you trust them enough to never verify their claims. However, if you later seek to verify their claims, your skepticism may be substantially diminished by your increased comfort level with them. In other words, you will accept the fraudster’s deceptive answers as factual, even if you have some doubts.

A common mistake made by victims of fraud is called "unexamined acceptance." Claims received from any source should not be taken for granted as being truthful and accurate without any critical analysis, investigation, and verification. Therefore, learn to exercise professional paranoia. Do not trust. Just verify

Apologies

Apologies are irrelevant. While contrition and forgiveness are admirable traits, apologies do not change the past or undo the harm caused by fraudsters. Apologies tend to make the victims feel a small measure of comfort and make fraudsters, as a minimum, appear remorseful. However, apologies should not be relied on to predict future behavior. People should be ultimately judged by their actions, not by their "well meaning" words or claimed "good" intentions.

Invisible White-Collar Criminals

According to the Association of Certified Fraud Examiners (ACFE) 2014 Report to the Nations on Occupational Fraud and Abuse, “Occupational frauds can be classified into three primary categories: asset misappropriations, corruption and financial statement fraud.” Less than 10% of fraud perpetrators had been previously charged with a crime or had criminal records. As the economic impact of an economic crime goes higher, it is less likely that the perpetrators involved have any previous criminal records. Did Bernie Madoff, Ken Lay (Enron), Bernie Ebbers (Worldcom), or Dennis Kozlowski (Tyco) have criminal records? The answer is no. Therefore, it is difficult for law enforcement and professionals to profile the white-collar criminals among us.

Most Fraud is Discovered from Tips

The ACFE 2014 report found that, “Tips are consistently and by far the most common detection method. Over 40% of all cases were detected by a tip — more than twice the rate of any other detection method.” Specifically, the study states that 42.3% of occupational frauds are initially detected from tips and 6.8% of such frauds are found by accident. Therefore, 49.1% of occupational frauds are found by tip or accident. Furthermore, the ACFE stated, “Management review and internal audit rank second and third, respectively, in frequency of detection, but they lag far behind tips.” Only 16.0% of frauds were detected by management review, 14.1% by internal audits, and 3% of frauds by external audits. Unfortunately, our society must primarily rely on the actions of whistleblowers to inform us about most frauds.

Who are the Whistleblowers?

While many whistleblowers are glamorized by the press, most of them are not motivated by altruism, but are motivated by revenge or personal gain. Every source has an agenda. To government investigators, it’s known as the XXX principle (and I am not talking about pornography).

Ex-lovers: Divorced spouses, former girlfriends and boyfriends.

Ex-business associates: Former customers and suppliers.

Ex-employees: Fired employees, laid off employees, and employees who quit working for the entity.

Whistleblowers can provide useful information. Most whistleblowers have an ax to grind and are looking to promote their particular personal agendas. They may have known about the crime during the execution of it, but did not report it until later. A whistleblower’s credibility should be judged on the basis of actionable verifiable information they provide, not what they say.

Do Audits Really Protect Investors?

Many investors blindly rely on the integrity of audits to protect them against fraud. Unfortunately, audits give investors a false sense of security. Traditional financial statement audits of public and private companies are not designed to find fraud. What accounting firms call an “audit” of financial reports is really a compliance review designed to find unintentional material errors in financial reports by examining a limited sample of transactions. In other words, traditional financial statement audits are designed to be spell-checkers and catch the accounting equivalent of innocent typos.

Despite the built-in limitations of audits, the major accounting firms do a poor job conforming to professional standards and rules for carrying them out. In 2012, the Public Company Accounting Oversight Board (PCAOB) inspected various audits conducted by the biggest four accounting firms and reported serious deficiencies in 25% to 49% of them:

Ernst & Young: 51 audits inspected /deficiencies (49%)

Pricewaterhouse Coopers: 52 audits inspected/21 deficiencies (40%)

KPMG: 48 audits inspected/17 deficiencies (35%)

Deloitte & Touche: 51 audits inspected/13 deficiencies (25%)

The latest inspection reports issued by the PCAOB for 2013 show that Pricewaterhouse Coopers had serious deficiencies in 19 of 57 audits inspected (33%) and Deloitte & Touche had serious deficiencies in 15 of 51 audits inspected (29%).

As a nation, we devote far more resources fighting blue-collar crime or street crime, than we do battling white-collar crime. For example, the NYC Police Department employs approximately 34,000 cops in uniform battling street crime. However, the FBI employs approximately 13,600 special agents, the IRS Criminal Investigative Division employs approximately 2,600 special agents, the SEC employs approximately 3,958 people, and the US Postal Inspectors Office employs approximately 1,500 postal inspectors. The NYC Police Department has more man power directly battling street crime than those four federal law enforcement agencies combined have fighting nationwide white-collar crime.

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one."Today, I advise federal and state law enforcement agencies about white-collar crime and trains them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach about white-collar crime for government entities, businesses, professional organizations, and colleges and universities. In addition, I perform forensic accounting services for law firms and other clients.